William Lyon Homes' (WLH) CEO Bill Lyon on Q2 2014 Results - Earnings Call Transcript

Aug.13.14 | About: William Lyon (WLH)

William Lyon Homes (NYSE:WLH)

Q2 2014 Earnings Conference Call

August 13, 2014 12:00 ET

Executives

Larry Clark - Investor Relations

Bill Lyon - Chief Executive Officer

Matt Zaist - President and Chief Operating Officer

Colin Severn - Vice President and Chief Financial Officer

Analysts

Scott Schrier - Citi

Michael Blewitt - JPMorgan

Alan Ratner - Zelman & Associates

Michael Dahl - Credit Suisse

Joel Locker - FBN securities

Alex Barron - Housing Research Center

Susan Berliner - JPMorgan

Michael Rehaut - JPMorgan

Operator

Good day, ladies and gentlemen and welcome to the Second Quarter 2014 William Lyon Homes Earnings Conference Call. My name is Whitley and I will be your operator for today. At this time, all participants are in listen-only mode. This call is being recorded and will be available for replay through August 27, 2014, starting this afternoon, approximately one hour after the completion of this call.

Now, I would like to turn the call over to Mr. Larry Clark, Investor Relations for the company. Please go ahead, Mr. Clark.

Larry Clark

Thank you, Whitley. Good morning and thank you for joining us today to discuss William Lyon Homes’ financial results for the three months June 30, 2014. By now, you should have received a copy of today’s press release. If not, it is available on the company’s website at www.lyonhomes.com. The press release also includes a reconciliation of any non-GAAP financial measures used therein. In addition, we are including an accompanying slide presentation that you can refer to during the call. You can access these slides in the Investor Relations section of the website. Before we continue, please take a moment to read the company’s Safe Harbor statement shown as Slide 1 in the presentation.

With us today from management are Bill Lyon, Chief Executive Officer; Matt Zaist, President and Chief Operating Officer; and Colin Severn, Vice President and Chief Financial Officer. We will begin the call with Bill providing an overview of our second quarter results, Matt will then discuss our operational highlights, followed by Colin, who will review our financial results. After our prepared remarks, we will open the call for your questions.

Now, I would like to turn the call over to William Lyon Homes’ CEO, Bill Lyon.

Bill Lyon

Thank you, Larry and welcome, ladies and gentlemen. I am pleased to announce that yesterday we completed the acquisition of the residential homebuilding business of Polygon Northwest Homes, the largest private homebuilder in the Pacific Northwest. This acquisition marks our entrance into the very attractive high barrier to entry markets of Seattle, Washington and Portland, Oregon. Today is our first full day of operations as a combined company and we are very excited to welcome the Polygon team to the William Lyon Homes family.

We look forward to partnering with Derek Straight, Fred Gast and the respective operating teams as two new divisions of William Lyon Homes. We are also very pleased that William Lyon Homes’ team delivered another solid quarter of results on a standalone basis. I would like to thank our entire team, their hard work on executing on our business, while at the same time helping to complete the significant acquisition. As we have discussed in prior conference calls, William Lyon Homes’ mission is to be the premier Western regional homebuilder. Throughout 2014, we have aggressively continued our pursuit of this goal and the acquisition of Polygon and entering the Pacific Northwest region represents a significant milestone on a path towards it’s achievement. This strategic acquisition firmly establishes us as one of the largest Western home builders with a presence in 11 core markets across six Western states. All of our divisions have leading market share positions in these highly desirable markets and we now own or control more than 18,000 lots representing approximately 8.7 years of lot supply based on last 12 months of deliveries providing exceptional priority to our future growth plans.

To give you a sense of our company’s size on a combined pro forma basis, over the last 12 months consolidated revenues were nearly $1 billion at $970 million. We had over 2,000 closings representing over $900 million in homebuilding revenue. We anticipate that this acquisition will generate significant cash flow, improve our SG&A leverage and be accretive to earnings. With a 20 year operating history Polygon is very complementary to us in terms of product offering and cultural fit. With a similar focus on high customer satisfaction and new home quality, they have deep local knowledge, strong relationships in their markets and primarily target move-up buyer.

Now moving on to our standalone quarterly results, in the second quarter of 2014 we continued to deliver strong performance across a number of financial and operational measures. Our net income increased by 79%, operating margins were up 380 basis points year-over-year and our revenue average selling price and dollar value backlog all posted significant double digit increases from the second quarter of 2013. Total revenue for the quarter was $179.8 million, up 37% from last year. Home sales revenue of $168.2 million was up 39% year-over-year and we delivered our 10th consecutive quarter of year-over-year growth in orders and dollar value backlog.

Net new home orders of 388 were higher by 8% and the dollar value of homes in backlog improved to $303 million representing an increase of 47%. We delivered 336 new homes in the second quarter of 2014 and our homebuilding gross profit grew by 66% to $39.9 million. Our homebuilding gross margin percentage improved 380 basis points to 23.7% compared to 19.9% in the year ago quarter.

On the expense side in the second quarter we maintained our low cost structure. Our combined SG&A expense was 11.9% of home sales which is a six year low for Q2 and a 90 basis point improvement over the year ago quarter. With the Polygon acquisition and in combination with our first quarter acquisition of a portfolio of coastal urban infill communities in our core California markets, we believe that we are now positioned in the 11 best market in the West which possess attractive long-term fundamentals including favorable employment and demographic trends.

With that, I will now turn the call over to Matt to discuss our second quarter operating results. Matt?

Matt Zaist

Thanks Bill. First I would like to recognize the efforts of both William Lyon Homes and Polygon Northwest teams worked tirelessly to enable us to complete this significant acquisition in a relatively short timeframe. I would also like to personally welcome all of our new team members from Polygon and echo Bill’s comments of how enthusiastic we are to be partnering with you as you continue to build upon your solid reputation of being a leading home builder in the Pacific Northwest.

Turning to our second quarter operating results, as Bill mentioned we continue to execute our growth plans as we reported a healthy quarter of year-over-year improvement in a number of operating metrics including revenue, ASP and dollar value orders as well as backlog. Our average sales price for homes closed increased 43% to $500,500 during the second quarter of 2014 compared to $349,700 during the year ago quarter. This reflects continued same store price appreciation and a shift in our delivery mix to higher price point markets homes and move-up buyers. 62% of our homes delivered in the quarter were in California compared to 29% in the second quarter of 2013. Additionally, we have been experiencing a measured shift towards more a move-up buyers throughout the company which represented approximately 74% of our deliveries in the quarter up from 62% in the second quarter of last year.

Our net new home orders for the quarter increased 8% to $388 million, with significant increases in our California markets based in part on the positive market response we have enjoyed in the new communities we have recently opened. Additionally, we ended the quarter with positive momentum as the month of June had the highest number of orders in the quarter, which were up 44% from June of 2013. Dollar value of orders increased 27% year-over-year to $195.4 million, which equates to $503,700 per home as compared to an average sales price of $428,400 for our orders during the second quarter of 2013. Our companywide cancellation rate was just 12% during the second quarter 2014 compared to 18% during the year ago quarter.

Our weekly sales pace was approximately 0.8 homes per community or 3.5 homes per month in the second quarter. Southern California led the way again with an absorption rate of 1.3 homes per week per community. The strong sales pace confirms our success of our California strategy of primarily focusing on the coastal markets with an emphasis on infill, which continues to experience healthy demand in limited supply. The dollar value of our backlog continued to grow in the quarter ending at $303.3 million, which represents a 47% increase year-over-year. The number of units in backlog was up 6% ending at 544 homes.

Our average sales price of homes in backlog at June 30, 2014 was approximately $558,000, which is 11% higher than the average sales price of homes closed in the most recent quarter. The use of buyer incentives had been very consistent quarter-to-quarter and historically low across the company with individual projects ranging from no incentives at all to 4% with the average of all closings for the second quarter at 1.25%. Current backlog contains incentives of just 1.2% of gross sales revenue. Similar to what we experienced in the first quarter, new homebuyer demand was somewhat mixed across our markets with particular strength in California partially offset by lower sales rates in Arizona and Nevada.

As we mentioned on last quarter’s call, we have seen the Phoenix marketplace experience a slower rate of sales in 2014 than we saw in 2012 and 2013. Our second quarter sales rate per community of 0.7 homes per week was slower than we had planned for, but still stronger than the 0.5 sales per week average for all new home communities in the overall Phoenix market. We remain optimistic about the long-term fundamentals of the Phoenix market as the region continues to post strong job growth and has favorable population outlook.

Phoenix is forecasting employment gains of approximately 40,000 jobs in 2014 and 50,000 jobs in 2015. Recently revised population growth estimates include increases of almost 70,000 people in 2014 and 100,000 people in 2015. Permits are expected to grow from approximately 11,000 permits in 2014 to 14,000 permits in 2015. We believe that the current market headwinds are result of a number of factors that should improve over the coming year.

The new home community count has increased approximately 50% in Phoenix from the midyear of last year to approximately 450 active subdivisions today. We currently estimate that approximately a third of those active communities will sell out by the end of this year with far fewer replacement communities coming online during that period of time. Additionally, we have seen stronger traffic on a year-over-year basis. And while we have seen the single family for rent investors buying fewer homes in the Phoenix market, we are seeing an increase in trued needs based buyers coming into our sales locations. We have an extremely attractive land position in well-located areas of the Southeast Valley and Northwest portions of Phoenix.

Our future community openings planned for the end of this year and early 2015 include well-segmented product, much of which fit under the current FHA guidelines, which adds to our optimism. In Nevada, while we saw an increase in total orders, we experienced a slower sales pace rate year-over-year. The slower rate of sales is really a tale of two buyer segments. We continue to see the true entry level buyer regardless of first time or not in Las Vegas, struggle with current mortgage underwriting standards as well as home prices that is significantly appreciated over the last two years. Those entry level projects have underperformed our expectation from an absorption perspective.

On the other end of the spectrum, the luxury move-up buyer continues to show a strong demand for well-designed new homes in superior locations. We have been purposely limiting our releases at these luxury communities to take advantage of price as well as provide homeowners an opportunity to make extensive options and upgrade selections. While absorptions were slower than the year ago period, we saw the dollar value of orders in Nevada increase 119% year-over-year. The average sales price and backlog for the division has increased to $734,000, up 137% from last year and is currently the highest in the company. Las Vegas continues to be one of the most land constrained markets in the west and one that we are excited about as we move forward.

While Polygon’s operations won’t be included in our results until the third quarter, I want to give you a quick snapshot of their second quarter results. Both Seattle and Portland continue to experience favorable demand driven by strong job growth against the backdrop of limited new home supply. For the second quarter, Polygon delivered 194 homes at an average selling price of $380,000. New home orders came in at 219 homes across 12 active selling communities, which is the strong sales pace of 1.4 homes per community per week. We are excited about all of the community locations as well as the diverse product mix and look forward to continuing the success as a leading homebuilder in both the Seattle and Portland markets.

We remain focused on executing on our operating strategy within our existing communities, while continuing to open new stores over the course of the next 12 months and we now expect to be selling from 75 communities by the middle of next year, including 16 in the Pacific Northwest, an increase of over 42% from the pro forma combined community count at the end of the second quarter. Consolidated land acquisition was approximately $85 million during the second quarter and our total lots owned and controlled combined with Polygon stand at approximately 18,400 lots. Based on our current outlook and lot supply, we have strong visibility into our growth plans as all of our 2014/15 and substantially all of our 2016 deliveries are currently owned and controlled.

For a discussion on our financial results, I will turn the call over to Colin.

Colin Severn

Thank you, Matt. As both Bill and Matt have discussed, we delivered another solid quarter in terms of both revenue growth and profitability. Once again, this was driven by strong results in California and our companywide migration towards the higher mix of our sales to move-up buyers. Total consolidated revenue for the second quarter 2014 was $179.8 million, up 37% year-over-year. Home sales revenue increased 39% to $168.2 million as compared to $120.6 million in the year ago period. The increase in home sales revenue was due to a 43% increase in the average sales price of homes delivered with prices rising across all of our divisions.

Our new home deliveries for the second quarter of 2014 were 336 units, down 3% from the prior year’s quarter. During the quarter, we experienced a backlog conversion rate of 68% comparable to the second quarter of 2013. Our homebuilding gross profit increased by 66% to $39.9 million during the second quarter compared to $24 million during the year ago period. Our homebuilding gross profit margin percentage improved 380 basis points to 23.7% in the second quarter of 2014 as compared to 19.9% in the second quarter of 2013.

We reported an improved adjusted homebuilding gross margin percentage of 27.2% during the second quarter as compared to 27% in the year ago period. We experienced increased margins across all of our markets as compared to the second quarter of 2013. In Southern California, gross margins were up approximately 20 basis points year-over-year, in Northern California, they were up 370 basis points, Arizona up 420 basis points, Nevada up 310 basis points and Colorado up 270 basis points. We remain focused on optimizing our profitability through a combination of strategic pricing and disciplined cost controls.

In addition to our strong gross profits, we continue to make progress on reducing our SG&A percentage. Our combined SG&A expense for the quarter was $19.9 million or 11.9% of home sales. This compares favorably with 13.3% sequentially and 12.8% in the year ago quarter. Our sales and marketing expense was 5.3% of home sales as compared to 5.1% in the second quarter of 2013 primarily due to increased advertising and model operations resulting from a larger number of recently opened selling communities in this year’s quarter as compared to the prior year.

G&A expense improved by 120 basis points to 6.5% down from 7.7% in last year’s second quarter as we are allocating costs over a larger number of active selling communities. Operating income for the second quarter doubled from a year ago to $20.6 million and operating margin increased 380 basis points to 12.3%. Our adjusted EBITDA increased 40% to $26.5 million for the second quarter of 2014 compared to $18.9 million in the year ago period. Net income for the quarter was $12.3 million or $0.38 per diluted share, as compared to $6.9 million or $0.29 per diluted share in the second quarter of 2013.

At this time, I would like to provide you some additional information regarding the anticipated impact of the Polygon acquisition on our results for the third quarter, as the operating results of Polygon will be included for the quarter beginning August 12, 2014. To be included in our third quarter results, we expect incremental new home deliveries from Polygon to be between 120 and 125 units with home sales revenue expected to be $44 million to $46 million. Also on the third quarter, we expect to have a one-time non-recurring expense of approximately $5 million. And we believe we will see meaningful improvement in our SG&A leverage on a go forward basis.

Now turning to our balance sheet, as of June 30, 2014, our total debt to book capitalization was 56.6% as compared to 51% at December 31st 2013 consisting of total equity of $472.2 million, a total debt of $616.6 million at the end of the quarter. Our net debt to net book capitalization was 52.1% at June 30, 2014, up from 39.7% at December 31, 2013 with cash of $103.3 million at quarter end. In conjunction with the acquisition of Polygon as previously mentioned, we issued $300 million senior notes due 2020 and borrowed $120 million from our new unsecured credit facility, which increased our pro forma total debt to book capitalization to 68.7%. In addition to the capital markets transactions we closed on a series of land banking transactions, which raised approximately $100 million in proceeds used in connection with closing the Polygon acquisition. We plan to reduce our leverage over the next 2.5 years and are targeting approximately 50% total debt to book capitalization by the end of 2016.

Now, I’ll turn it back to Bill.

Bill Lyon

Thank you, Colin. This is a very exciting day for us as we begin a new chapter and take a big step forward in the continuing growth of our company. Polygon has a strong repetition for quality home construction and excellent customer satisfaction and has a highly desirable portfolio of land positions in some of the best markets in the United States. We are well positioned to capture the benefits of the market dynamics still at work in what we believe to be a multi-year housing recovery. We are in all the right Western markets in terms of home price appreciation and sought after lifestyle characteristics. These markets with proximity to job centers strong school systems and improving employment and wage growth. Our philosophy of having a strong market presence in the most attractive markets is best way to support our current and future growth. We believe this will enable us to continue drive attractive shareholder returns.

Thank you again for joining us today. I would now like to open the call to your questions. Operator we are ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Will Randow with Citi. Please proceed.

Scott Schrier - Citi

Hi, this is actually Scott Schrier for Will. Thanks for taking my questions and nice quarter. Just wanted to – I just wanted to touch on the – hey I just wanted to touch on the absorptions and I really appreciate the color you gave on them. Since they slowed a little bit, is there any additional commentary you can give on and how we should look at the absorption pace for the back half of the year?

Matt Zaist

Well, I think that your – historically if we were in a normalized market there was experienced typical seasonality we would obviously see slightly stronger absorption rates in the first half of the year versus the second half of the year. I think obviously we saw some of our markets perform consistent with where we were expecting them to perform for the first couple of quarters. And those that were slightly slower, I think as we kind of look into at least the first part of the third quarter I think we are seeing the markets were strong. The first half of the year continue to be strong primarily being the costal markets in California and the Pacific Northwest and improvement in Colorado. I think that the sales pace in Phoenix and Vegas nothing meaningfully has changed quarter-to-quarter. I think if you look back at last year’s third quarter I think we gave some color on our third quarter earnings call relative to absorption paces in the third quarter getting a little bit of a pickup in September which is not uncommon, but I think we are kind of expecting to see on an absorption basis something similar to what we saw last year between the second and third quarters.

Scott Schrier - Citi

Great. Thank you. That’s helpful. And I wanted to touch a little bit on the incentives that you are talking about, can you just discuss a little bit the incentives that you are seeing in Phoenix and in some markets and kind of how home buyers have responded to those incentives? Thank you.

Matt Zaist

Yes, Scott it’s Matt again. I think as we stated our incentives across the company are ranging and averaging about 1.25%. Divisionally Phoenix is slightly higher than our other divisions running second quarter as well as backlog right around 2.75% to 3%. It ranges in every market in terms of what builder strategies are relative to incentives. We haven’t seen anybody be overly successful by using straight incentive dollars to outperform at least projects that we see ourselves competing with obviously markets are broad, we think competition really has to be looked at on a project by project basis. And so typically for us the use of incentives has for the foreseeable future and tends to be some form of closing costs usually tied to using preferred lender it might be used by a buyer for options and upgrades. But again we don’t think that just the use of broad based incentives is something that is going to necessarily drive outperformance in our markets.

Scott Schrier - Citi

Great. Thank you. I appreciate the color.

Matt Zaist

You bet.

Operator

Your next question comes from the line of Michael Blewitt with JPMorgan. Please proceed.

Michael Blewitt - JPMorgan

Thanks. Good morning everyone and congrats on the closing of Polygon.

Matt Zaist

Thanks Mike.

Bill Lyon

Thanks Mike.

Michael Blewitt - JPMorgan

First question I had just kind of going back to the sales pace for a moment, I mean if you look back over the last two or three years it’s kind of certainly kind of had a wide range of results. And it would seem that at least in the second quarter to a degree things are perhaps coming back more to a normalized pace, I wanted to know if that’s a fair characterization in your view if some markets maybe like Arizona certainly are even more challenged than that and maybe suboptimal or subnormal. And how to think about now that you have Polygon in the – in your portfolio and it’s part of the company at least on a combined basis I mean obviously you have a lot of different markets, but just trying to get a sense of the pace that we are seeing right now adjusted for seasonality is that kind of the desired pace that you are expecting going forward, would you expect things maybe in a couple of markets to improve a little bit like in Arizona maybe California, Southern Cal to perhaps even further cool off slightly, just how to think about like 2015 as we move forward?

Matt Zaist

Sure. Mike, it’s Matt, I think you touched on a lot of things that I think are very relevant I think our view is 2014’s pace in Arizona is below normalized pace. And our expectations are that that market will see improvement in 2015 and beyond. So I think we would anticipate absorption being slightly higher on a go forward basis at least in ‘15 for Phoenix. I think that California which has continued to operate really at a slightly higher pace than what is considered to be normal. So if you blend all things together and also roll Polygon in which has historically in their markets run at slightly higher than one a week for the year, I think we would look at kind of the blended rate of right around or just below one a week being kind of optimal. I think it as kind of a four a month pace for project blended across the company.

Michael Blewitt - JPMorgan

Okay. So that’s essentially your expectations for obviously much can happen between now and then, but as you kind a normalize those would be expectations that you would hope to see next year?

Matt Zaist

That’s correct.

Michael Blewitt - JPMorgan

Okay. Also the gross margins I was hoping particularly with Polygon if you would give us a sense again more for like the 2015, but with the movement on the balance sheet how to think about interest amortization running through COGS, if there would be any interest expense that wouldn’t be able to what would be capitalized and runs straight through the balance sheet? And I just have one quick follow up as well.

Colin Severn

Sure. I mean I think on the second part first there on your – this is Colin by the way. Your interest in cost of sales we are thinking a short-term at least in the third quarter maintain and its current levels that we have now. We are at 3.5% of revenue. Obviously our cost of capital moving forward will have some impact on that. We can see a slight uptick in the fourth quarter. And then we have to see what happens to that cost of capital move into next year. So I wouldn’t want to give color on ‘15 just yet on that.

And then on margins in general there are several factors that we need you consider. First obviously, the purchase accounting associated with Polygon, which will see it’s biggest impact on margins in the first couple of quarters of inventory turn and then margins will expand over time. And then relative to the Lyon’s backlogs on a standalone basis, we are seeing a couple of things that may impact margins first, 30% of our backlog as houses that are benefited from fresh start accounting versus about 50% number last year. So that means as more of our active selling communities today especially in California land with a newer vintage land basis.

Our current backlog also as a number of houses about 30% that was in master plan communities, a number of which have profit participations that have a bit of impact on margins as well. So, net-net we think margins will be a bit lighter in the coming quarter, but there is a lot of variables in there. So it’s difficult to give you a number, but that’s a bit of color hopefully they can help you. But for us it’s really a function of what’s currently turning on our books more there any material changes in variable costs or pricing strategy.

Michael Blewitt - JPMorgan

And I appreciate that Colin and I guess just the clarification on the gross margin percentage for Polygon for 2Q at 30.4%, is that pre-interest or comparable to your fully loaded 20.7 and also if you can give us a sense of the dollar impact from the purchase accounting any help there for first 3Q and 4Q?

Colin Severn

Yes. First part, the Polygon margins or GAAP margins are fully loaded inclusive of interest. And then a bit early for us to give you dollar value on the margins on Polygon, lots of factors are obviously we just closed today, we need to get into detail a bit more, but hope to give you big color or so.

Matt Zaist

Mike its Matt. The other thing we did is if you look at the bond OM, there is somewhat of a bridge in terms of how we are allocating purchase price across inventory. So, if you want to take a look at that relative to likely allocations and write up of inventory that will help you I think bridge kind of those margins as well.

Michael Blewitt - JPMorgan

Okay. One last quick one if I could, SG&A longer term, how are you thinking about it, you have obviously had a great amount of success in the first half of ‘14 versus ‘13 in terms of leverage particularly on the G&A side, any thoughts around where that could be in the next two or three years?

Matt Zaist

Yes. Mike, it’s Matt, I think as Colin alluded very happy with what we have accomplished in the first half of this year in terms of progress as well as candidly in the back half of ’14 we have got some – as Colin said some acquisition related expenses for bankers, lawyers and auditors that are kind of a one-time event that will run through G&A in the third quarter. But as we look at ’15 I think one of the things that we candidly really are excited about relative to this acquisition and what it means for helping us continue to improve operating margins sequentially from ‘15 compared ‘14 and ’16 compared to ’15 Polygon’s fully burdened SG&A rates. We are running at sub-8% and obviously we think that by adding them to us as well as not having their entire corporate structure burdened on their operations we think that we can drive SG&A in 2015 to if not at least 9% hope to do better than that in ’15 and certainly somewhere in the mid-8s for 2016. So we think that that’s an area that we are certainly going to spend a lot of time on and create value for everybody.

Michael Blewitt - JPMorgan

And that’s obviously on a fully consolidated William Lyon plus Polygon basis?

Matt Zaist

Correct.

Michael Blewitt - JPMorgan

Great, perfect. Thanks so much guys.

Matt Zaist

You bet.

Operator

Your next question comes from the line of Alan Ratner from Zelman & Associates. Please proceed.

Alan Ratner - Zelman & Associates

Hi guys. Congrats on the Polygon deal and that SG&A guidance Matt is very impressive, just on the corporate G&A you have been running kind of in that $11 million to $12 million a quarter range, what do you anticipate that going up to on the Polygon’s side, it seems like based on that guidance it should be a pretty insignificant incremental expense there?

Matt Zaist

Yes. Alan, first thanks for your wishes. Look I think we look at might be some incremental raw dollars associated with it but we don’t see G&A being a meaningful change on a quarterly run rate going forward. I think this is natural just as you grow and we obviously plan on growing. There is certainly some incremental costs that are associated with that but nothing that we think is going to meaningfully move the needle that’s really driving what we consider to be some great improvement on the SG&A side.

Alan Ratner - Zelman & Associates

Great. And on the margin and Colin your commentary on the kind of timing of the master plan deliveries is helpful, you have kind of trended from about 30% kind of adjusted margin in the second half of last year down to about 27% now. And I guess once the dust settles with Polygon and the purchase accounting headwind subsides and you start bringing on communities from the City Ventures portfolio. How should we think about that gross margin on that adjusted basis longer term is something closer to 25% realistic or do you think you can be north of that kind of closer to where you are today?

Matt Zaist

Alan, it’s Matt, I think we have historically not given longer term guidance relative to that. I think a lot of what’s going to take place in ’15 and ’16 from our gross margin perspective really is it depends upon a number of factors including sales prices on homes that aren’t even in the marketplace selling today. So I think we have historically haven’t given forward looking guidance on margins to that extent.

Alan Ratner - Zelman & Associates

Okay. And then just on Nevada there is a big gap between your backlog and pricing north of 700 versus where you are delivering today, how should we think about that playing out, is there going to be it’s kind of a big jump up next quarter or is that going to be more gradual as those higher priced communities begin delivering homes?

Matt Zaist

Yes. Alan it’s going to continue to increase over the next couple of quarters it’s – those homes when we get up into those higher price points, especially with kind of extensive options and upgrades, cycle times typically are little bit longer on those houses, which is why we have seen the backlog up quicker and higher than kind of the ASP increase, but we would expect to see that continue to grow. I think you will start to see that tick up in the third quarter and probably a bigger adjustment in the fourth quarter and beyond.

Alan Ratner - Zelman & Associates

Great, thank you.

Operator

Your next question comes from the line of Michael Dahl of Credit Suisse. Please proceed.

Michael Dahl - Credit Suisse

Hi, thanks and also congrats on the Polygon deal. Couple of questions on community count and then thanks for the guidance on the 75 for midyear next year, obviously this is pretty early on in your ramp up phase. So, just your thoughts on was there anything incrementally that got accelerated as far as giving you comfort to guide to that 75 and then beyond the 75, if you think about the trajectory that you control today, is there any commentary you can give us there?

Matt Zaist

Yes. I think as we look at clarity surrounding that, I mean, obviously being about a year out from kind of where we are guiding to on that, I think we feel good in that everything relative to that community count guidance is owned today. It is projects that in almost all cases we are actively working on. So, that’s in some cases that’s projects that we expect to open the balance of this year and first quarter of next year, which means we have got finished lots in hand today and are actively moving on model complexes for those communities that are opening in the back half of the second quarter. There were projects that we are currently working on horizontal development. I think we have obviously spent time talking with Fred and Derek as part of the Polygon team in that integration and making sure that we understand where their community count is coming from and what the status is of each of those development projects. But I think really that clarity a year out is something we have tried to continue to give guidance on from a quarter-to-quarter basis is really where we see community count going over the next 12 months. So, beyond that, obviously we have got a great lot supply. We expect community count to continue to grow beyond that. I think it’s just getting a little bit more than a year out. Mike just is a little bit tougher to pinpoint with the certainty that we feel like we can give relative to midyear next year.

Michael Dahl - Credit Suisse

Got it. That’s helpful. And then as a follow-up I guess on – in Phoenix specifically, you gave a lot of color around how you think about it from competitive and a pricing standpoint as far as hitting the right price with some of the new communities. Any thought as far as is the timing just of these communities lining up so that you will be facing less competition as they come on or are you potentially delaying or thinking about delaying some of these openings to give the market a little time to clear before you bring on the next round?

Matt Zaist

Good question. We are not planning on delaying any of our new projects that we are introducing. We have given some prior color on we have got a large development project that’s in the Southeast Valley in Queen Creek, which previously was referred to as our Church Farms project renamed Meridian. That project has got five new communities that we plan on getting opened kind of split between the end of the fourth quarter and into the first quarter of next year. That’s something that is planning on being open consistent with prior guidance up in the Pacific or – excuse me up in the Northwest portion of Phoenix, we have got new project opening up in the first quarter of next year.

Relative to kind of what we are seeing is we have seen a huge run up in the broader marketplace of new communities coming to market. I think obviously there was a lot of land buying that went on a year ago in Phoenix, which resulted in kind of the new communities coming online this year. We have seen the land market in Phoenix cool a bit, the less deals being bought which effectively equate to less new communities opening up this year relative to the burn off of approximately third of the active selling communities. We are just really tracking all the new home communities, how many units they have left, what their sales pace has been to try to determine what’s rolling off and what’s coming online. I think a lot of the new home communities that got brought on especially in the Southeast Valley had very little product segmentation in them. I think we saw a lot of projects positioned. We had a few communities ourselves that got caught up in the lowering of the FHA guidelines or low limits last year from last year, this year rather. And I think that we spent a lot of time earlier this year as we were finalizing our product for our new communities to make sure that we have got great segmentation within our communities and that we are also – have an ample amount of product available to fit under that FHA guideline as well as move-up product.

Michael Dahl - Credit Suisse

That’s great. Thanks.

Matt Zaist

You bet.

Operator

Your next question comes from the line of Joel Locker with FBN securities. Please proceed.

Joel Locker - FBN securities

Hi guys. Just I guess curious on your just average selling price in 2015, if you have kind of a ballpark figure assuming the market conditions don’t change on home pricing going forward?

Matt Zaist

Yes. Joel, I think we have – I think you can obviously take a look at kind of what our current backlog is. You can take a look at Polygon’s backlog and start to try to map that out. We would expect the ASPs across the board in ‘15 to be a bit higher than what’s in 2014. We also bring on a number of the kind of urban infill deals associated with the prior City Ventures acquisition. So, net-net, without any sort of expectations on price appreciation we would expect to see ASPs in ‘15 higher than ASPs in 2014, but I don’t think comfortable giving an exact estimated number.

Joel Locker - FBN securities

Right. And also if you are looking at obviously Polygon’s absorption close to 6 a month is pretty much industry high, do you expect that to continue or you think that might come in the 4 to 5 range as you go forward say into ‘15 and ‘16?

Matt Zaist

Well, it’s Matt again. I think as we look at their rate of sales, obviously they have been consistent for a number of years at a higher rate of sales, while also producing some great margin. I think at current sales paces, we see opportunities certainly for some incremental price increases, but I think relative to their operating strategy and their cycle times, I think that on a go forward basis somewhere between 4 and 6 would be a good number for them. I think the higher that number is the more opportunity there is to continue to push price. If it’s closer to that 4 number, it’s still working well and it’s going to work with their cycle time expectations.

Joel Locker - FBN securities

Right. And just two last questions on, what was the spec count just for William Lyon’s at the end of the second quarter and what goodwill if any is going to be attached to the Polygon acquisition?

Matt Zaist

Sure. I think relative to specs, we are averaging two completed specs per project at the end of the quarter. Relative to goodwill, we have outlined in the offering memorandum for the debt some preliminary thoughts at that point in time on purchase price allocation. Obviously that will get finalized over the balance of this quarter, but that will give you a little bit of a snapshot.

Joel Locker - FBN securities

Alright, thanks a lot guys.

Matt Zaist

You bet. Thanks Joel.

Operator

Your next question comes from the line of Alex Barron with Housing Research Center. Please proceed.

Alex Barron - Housing Research Center

Hey, good morning and congratulations guys.

Matt Zaist

Thanks Alex.

Alex Barron - Housing Research Center

I wanted to see I don’t know if I missed it, but could you guys discuss the progression of sales throughout the quarter and any comments on July?

Matt Zaist

Well I think as we have mentioned relative to sales through the quarter. June was our strongest month in terms of net absorptions and obviously it was the most significant increase year-over-year to 44% total order increase. I think it was we really kind of saw May as a – it’s kind of the low point in the quarter. Relative to July I don’t think we have got the exact numbers right in front of me, but I think as we have mentioned previously I think seeing July all-in-all pretty similar in terms of absorption rates we saw during the second quarter.

Alex Barron - Housing Research Center

Got it. And in terms of incentives I know you gave us your – what you guys are doing, but have you noticed any significant pickup from your competitors in any of your markets?

Matt Zaist

Alex, we are seeing certain people advertise incentives more, I think that the coastal markets and I think California as well as Pacific Northwest still seeing pretty limited advertising or use of incentives at all. I think when you look at Phoenix and Vegas I think we are seeing certain people advertise incentives on specific houses. We certainly haven’t seen as much that’s just kind of a broad brush approach to increased incentives. I think in Las Vegas if you look as I mentioned that entry level buyer and particularly if you look the City of North Las Vegas submarket you will see a little bit of a pickup in that submarket relative to builders trying to move standing inventory a little bit more aggressively. Colorado use of margins seems to be almost always typically mortgage incentive or maybe slightly more option and upgrade related incentives certain builders including maybe a full basement instead of a partial basement and things of that nature.

Alex Barron - Housing Research Center

So nothing that is to out of work with the last three months?

Matt Zaist

We haven’t had as we have talked with each of our operators and lead sales managers like I said you will see the one-off house here and there the standing inventory being a little bit more aggressively marketed. We have been a lot more isolated in California to the coast, so I can’t give our personal color on the Inland Empire, the Sacramento or Central Valley markets right now.

Alex Barron - Housing Research Center

Great. Thanks guys.

Matt Zaist

You bet Alex.

Operator

Your next question comes from the line of Susan Berliner with JPMorgan. Please proceed.

Susan Berliner - JPMorgan

I am sorry. My questions have all been answered. Thank you.

Matt Zaist

Thank you.

Bill Lyon

Thank you.

Operator

Your next question comes from the line of Michael Rehaut with JPMorgan. Please proceed.

Michael Rehaut - JPMorgan

Thanks. Just a couple of follow-ups here, one Matt you mentioned about in answer to your question about ASPs for next year that you would expect them to be higher given the backlog trends, but I presume what you are referring to there was just that William Lyon on a standalone and Polygon on a standalone you would expect each of those businesses the ASPs to move higher. Certainly your own backlog would suggest that for you. But on a mixed basis as you put out the – one Slide 5 with the mix shift of Polygon’s ASP would have resulted in a lower ASP for the combined company. So I would presume that aside from the each standalone’s improvement that you are referring to that more on an individual basis. I mean it would seem that on a mix basis perhaps the combined business might have a little bit of a lower ASP even with or is it just that the backlog is so powerful right now for your own business that would overwhelm the negative mix from Polygon?

Matt Zaist

I think that we have got a couple of factors that are in that. So, on Page 5, that was the ASP for closings for the second quarter and what that impact would have been. I think as we look ahead on a combined basis, we would expect, you are correct in assuming that obviously you can see William Lyon’s ASP in closings at 500, backlog at 550, Polygon at 380, we would expect that 380 to continue to trend upwards on Polygon’s as we move through 2015 with some higher price point houses being opened in the first couple of quarters of next year. Net-net, as I look at that 500 ASP for William Lyon in Q2 and look ahead on a consolidated basis in 2015, net-net we would expect it to be higher than that 500, just not prepared to give you an exact number.

Michael Rehaut - JPMorgan

Okay. And I appreciate that. And I guess just similar question, Colin, regarding the gross margins, I mean, excluding purchase accounting for a moment, that 30% at least that, that was generated in 2Q assuming that, that’s a number that’s indicative of their business going forward is a 600, 700 basis point delta versus your current gross margins? And again, outside of the eventual mix shift of the fresh start accounting in the master plans, which in my view is more of a gradual impact to gross margin, still negative mix, negative impact, but the more of a gradual one. It would seem that again to the extent that, that 30% gross margin of Polygon’s is indicative of the go forward business, it would result in a positive mix for your consolidated gross margins in ‘15? Am I thinking about that right or is there something else I am missing?

Matt Zaist

Well, Mike, it’s Matt. I am not sure 30% is pre-purchase accounting allocation. So, remember that we are going to – we are going to take the purchase price, we are going to reset their inventory basis and then that’s going to be the new margins coming out the back end. So, I think that while we are optimistic about the new deals they continue to buy and perform well on, I don’t think it’s appropriate to expect that they are going to have 30% gross margins post-purchase accounting in 2015.

Michael Rehaut - JPMorgan

Yes. I mean, I guess, I was just more thinking of as you burned through the purchase accounting impact, if that 30% is something or even in the high 20s is something that is sustainable or not, because I think a lot of people would, the purchase accounting is there, but it’s something that’s identifiable and people would potentially look past that over time?

Matt Zaist

Well, I think we said – I don’t think we were real comfortable giving margin guidance out into future years. I think the 30% I think is indicative of the fact that their current book basis of inventory was substantially below market, which is enabling us to absorb the cost of the acquisition and mark the inventory at a reasonable basis and be profitable on the back end of the deal. I think trying to say what’s normal, what’s not, obviously you can – we have got historicals for Polygon as well as all builders that are available, margins ebb and flow, but I think based on what we are seeing in current market conditions, based on what their current lot inventory is. And we gave some color previously in terms of what the vintage of their lot basis is, the 30% for them on a GAAP basis is really more indicative of how we view the basis of their land and helps bridge that purchase accounting allocation that was previously disclosed.

Michael Rehaut - JPMorgan

Okay. One last one if I could just on the sales pace, you mentioned how June had a very strong order growth number and that July sales pace was similar to 2Q, I mean, but as you mentioned earlier in the call, typically the back half of the year, you do see the sales pace fall off versus the first half in particularly 3Q versus 2Q, given the strength in June, given that you are saying July was similar to 2Q, would that falloff be a little less dramatic this quarter or are there just August and September, there is still a couple of months to go and it will be more appropriate?

Matt Zaist

Yes, I think it’s probably too early to tell just yet, Mike. I mean, I think that’s third quarter typically has got a lot of variability with heat in the desert and people being on vacation and kids being out of school, just it’s probably one of the tougher quarters to peg which is why I think what we said earlier on was all things being equal, we look back to pace differential last year, which I think showed some reasonable seasonality to it from quarter-to-quarter as kind of how we are looking at expectations for the quarter. Obviously, we are going to just like we do everyday, you come to work and try to sell as many houses as we can and close as many houses as we can and we will obviously give you what those results are once we know them.

Michael Rehaut - JPMorgan

Alright, fair enough. I appreciate it guys. Thanks.

Matt Zaist

Yes, Mike. I appreciate it.

Operator

That concludes our Q&A. I will now turn the call back over to Bill for closing remarks.

Bill Lyon

Thank you. I’d like to thank all of you for joining our call today. We look forward to providing you regular updates on our progress. If you have any additional questions, please feel free to call or e-mail us. And again, thank you for your participation and have a great day.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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